America’s Oil Supply: The Keystone for Survival

A rancorous debate over TransCanada Corp.’s (T.TRP) proposed Keystone XL Pipeline has given rise to two uncomfortable prospects: If the US$7 billion project is not built, Alberta’s oil sands will become landlocked, at least for a while, and the United States will lose access to one of its few reliable, friendly sources of oil.

Keystone XL is a proposed pipeline that would run from Edmonton—the hub of Canada’s massive oil sands—through Montana, South Dakota, Nebraska, Kansas, Oklahoma, and Texas, to Houston. The line is critical to ensure a continued, smooth ramp-up in oil sands production, because producers need to send the heavy bitumen extracted from the sands to refineries able to handle that kind of crude. Since refineries in the Midwest are reaching their heavy-oil capacity, it needs to go to the Gulf Coast.

Keystone XL is also critical for U.S. oil security – the U.S. is the world’s biggest importer of oil and, as we recently outlined in the Casey Energy Report, almost half of its oil comes from unstable, unfriendly, or declining producers (think Nigeria, Venezuela, Saudi Arabia, and the like). Canadian oil sands may be an environmental controversy, but in terms of U.S. energy security they are a lone bright spot. Denying Keystone XL equates to denying the U.S. its only significant friendly, stable, and growing source of oil.

The pipelines that currently carry bitumen from the oil sands to refineries in the Midwest will reach maximum capacity in as little as four years. At that point, oil sands producers would be stuck with growing volumes of oil and waiting for other transportation options to materialize. Those options would take several years to develop, even if efforts begin now.

The Keystone XL pipeline is so important that most in the oil patch haven’t even considered the possibility that it will not happen. Indeed, companies have already signed up to fill most of its capacity. Yet the pipeline has fomented heavy debate in the U.S., pitting legislator against legislator and one government department against another. Opponents say the project threatens key water resources, increases U.S. ties to hydrocarbons, and supports the environmentally destructive oil sands. Supporters say the pipeline would create tens of thousands of jobs and potentially lower oil prices in the U.S. because of ensured access to oil supplies from a stable, local source.

The oil sands hold 171.3 billion barrels of oil in reserve. For context, Saudi Arabia’s reserves stand at 264.2 billion barrels. The enormity of the oil sands resource has raised the stakes for both sides in the pipeline debate and placed undue importance on the outcome.

The decision lies with the State Department, because the pipeline crosses international borders. Secretary of State Hillary Clinton is expected to announce her decision before the end of the year. The department already issued a preliminary environmental impact assessment, which seems generally supportive of the project. For example, the State Department concluded that if Keystone XL is not built, oil sands production will be diverted to other markets (such as China), and the refineries in Texas will continue to process bitumen apace from offshore platforms. As such, the pipeline would not increase production of greenhouse gases.

The U.S. Environmental Protection Agency (EPA) does not agree. In a letter to the State Department this week, the EPA argued that the project poses serious environmental risks and that the State Department’s environmental review process was seriously flawed.

The EPA also laid out six specific demands for the State Department’s review, including: extending the cumulative greenhouse gas emissions impact assessment from 20 years to the pipeline’s 50-year lifespan; collaborating with the Department of Energy to assess the need for the pipeline and how it fits into President Obama’s goal to reduce U.S. oil imports; and analyzing other reasonable routes for the pipeline that avoid ecologically fragile areas (such as Nebraska’s Ogallala Aquifer and Sand Hills region). Other concerns include potential impacts to groundwater in the event of a spill and high pollution from refineries along the Gulf Coast that would process the bitumen.

Environmentalists are openly using the project as a proxy for their general opposition to oil sands development. Since environmentalists have framed the debate in that sense, Clinton’s decision will have ramifications far beyond the pipeline: It will set the tone for the U.S.’s perspective on the oil sands. But even though environmentalists would celebrate a Keystone denial, their method may be moot, because denying TransCanada approval for Keystone XL would only hinder oil sands development for a few years.

The thing is, if there is no Keystone XL, Canada will find other ways to export oil from its vast oil sands. And if the United States doesn’t want the oil, other markets will.

The U.S. is Canada’s next-door neighbor and the world’s largest importer of oil, so it is the most logical market for oil sands bitumen; it currently buys almost every drop that Canada exports. If Keystone XL does not become a reality, oil producers in Canada have several alternatives for reaching the U.S. One option is to ship by rail. Last fall, Altex Energy, in a joint venture with Canadian National Railway (CN), started shipping small amounts of oil sands crude along CN’s tracks all the way to the Gulf of Mexico. Transporting by rail avoids billions of dollars of infrastructure costs, avoids the need for any regulatory review, and eliminates the need to dilute the crude with chemicals to make it flow more easily. The drawback: It is considerably more expensive than pipeline transport.

There are also other pipelines available, such as the Trans Mountain pipeline that transports crude from the oil sands to Canada’s Pacific Coast. There, it can be loaded onto ships and taken to distant refineries. That pipeline is near capacity, but owner Kinder Morgan is considering an expansion. Another Canadian company, Enbridge, is proposing a new line from the sands to the northern British Columbia port of Kitimat.

If the U.S. says “no” to Keystone XL, watch for the Chinese to step up in support of these proposed pipelines, since oil transported to West Coast could easily be shipped across the Pacific to the world’s second largest oil importer.

There is political support for these projects, bolstered by a national election in Canada that reelected a Conservative Party government. The Conservatives’ traditional power base is in Alberta—home of the oil sands—and the party supports oil sands development whole-heartedly. New pipeline capacity is so important to the government that Alberta Energy Minister Ron Liepert thinks it needs national, and even international, consideration.

“If there was something that kept me up at night, it would be the fear that before too long we’re going to be landlocked in bitumen,” he said. “We’re not going to be an energy superpower if we can’t get the oil out of Alberta.” At a meeting in July, Mr. Liepert plans to urge his federal and provincial counterparts to adopt an energy strategy that makes the development of crude oil export pipelines a matter of national importance. He also will urge Canada’s federal government to approach Obama’s administration about a continental energy pact, committing the U.S. to providing market access to Canadian oil in exchange for security of supply.

So where do we stand? The State Department’s next step is to release a final environmental impact statement. That will start a 90-day countdown, during which other federal agencies—including the EPA—can weigh in on the project. While all of this is going on, five senators from Nebraska are asking Hillary Clinton to delay her decision until May 2012, to give Nebraska time to beef up its oil pipeline regulations.

Once the comment period is over, Clinton will make her decision based on whether the cross-border pipeline is in the national interest. However, the EPA can appeal that decision to President Obama if the State Department does not address its concerns. As such, the fight—which has already dragged on for two and a half years—could still last for some time. But at the end of the day, it seems the heated battle over Keystone XL may be little more than a symbolic clash of ideology—albeit one that threatens America’s only solid supply of friendly oil and one that would delay oil sands developments only for a few years. Oil makes the world go ‘round, and the denial of one pipeline is not going to stop oil sands development.

As we mentioned earlier, the Casey Research energy team just completed an in-depth investigation of who supplies the U.S. with its oil; we concluded that U.S. supplies are very much at risk. More than 40% of the country’s oil comes from suppliers with declining outputs or those that we classified as At Risk or Unfriendly, because their relationships with the U.S. are rocky or because the countries themselves are inherently unstable. (If you are interested in our report, consider subscribing to the Casey Energy Report, which is the main outlet for our energy market research.)

Canada is a lone, bright light in the U.S. oil-supply picture. The Keystone XL pipeline is an important part of that picture. A decision to deny the pipeline would represent a serious threat to America’s energy security... and a boon to China, which would gladly build infrastructure and buy up Canada’s oil sands production.